Markets & Finance

BusinessWeek

After Doug Duschatko lost most of his money in the stock market during the dot-com bust of 2000, the computer chip developer was so disgusted he decided to invest in real estate. His friend, William Shopoff, now principal in The Shopoff Group, was putting together limited partnership deals to acquire properties in California.

Duschatko started investing in 2000. He has invested about a $1 million and he estimates that he has more than doubled his money. He continues to hold properties through Shopoff including Carbon Canyon, a community of lots for homes in Orange County, with mountain and ocean views.

"As a limited partner, you don't have to do any of the work," Duschatko says. "I'm not cutting deals. I just put up my money and share in the economic benefit." The 48-year-old Duschatko says thanks to his investments, he hasn't had to work for five years, and now he's "semi-retired."

The Shopoff Group is a real estate limited partnership with between 400 and 500 investors and a portfolio worth about $400 million. It is open to selected "sophisticated" investors, typically those with a net worth over $1 million or a couple with an annual income of $300,000. The Shopoff Group is considering forming a public company, Shopoff Properties, that would be a real estate investment trust, another type of tax-advantaged real estate investing vehicle.

Limited-partner investors in such vehicles contribute the capital but have no management or operating role -- or liability. LPs receive favorable tax treatment, allowing the partnership to pass through any losses to LP investors and enabling them to avoid double taxation of income.

A WAY IN. Shopoff's firm offers a view into a type of real estate investing that is out of reach to most. Limited partners have the opportunity to choose their investments and get in on deals they might not ordinarily be able to afford -- or have the specialized knowledge to pursue. For example, "value enhancement" attributes, like zoning changes, can boost a home's worth by more than 30% a year -- the annual average for the Shopoff Group -- yet many people don't know how to research such things.

SIGN THE PAPERS. Jeff Amos, who renovates properties in Dallas, says he recently bought a stake in a plantation on the big island of Hawaii, a lush green jungle that overlooks the ocean. In January of this year, Shopoff sent him some material about the residential property near Hawaii's Kona airport. Amos liked the fact that local politicians had been developing the residential property and that it will eventually be adjacent to commercial areas drawing homebuyers.

After a couple weeks of mulling the deal over, he decided to buy into the project and wired the money to the Shopoff Group. Under the agreement, he'll get a percentage of the profit (he declined to say how much) when the property is sold. "It's pretty simple," Amos says. "You just sign the paperwork."

If Shopoff brings in more people like Amos in a public offering, the move has potential advantages for the portfolio and the investors. The initial public offering would pull in capital while lowering the price of admission for investors. And investing in a company's stock -- rather than in a specific property -- is a way to avoid heavy losses if a single property sours.

JUST A FEW. There are caveats to investing in these partnerships. "Unless you're sophisticated -- whether it's publicly offered or not -- you should stay away from [LPs]," says Thomas J. Hakala, a managing director at the wealth advisory firm Wilmington Trust in New York. He says that real estate partnerships typically have 8% to 10% of essentially tax-free return, but you have to take the risk that the projects will continue supporting themselves. The taxes on these deals get complicated, notes Hakala. He doesn't think anyone should buy into one without regular advice from a very skilled certified public accountant.

"It's probably riskier to do (a real estate partnership now) than it was three or four years ago, but regardless of the conditions, there is probably always a good investment out there," Hakala says. As a general rule, he thinks the best deals tend to have the fewest number of investors in them. Why would anyone bother to market to 100 people when you could sell to 10? "It's not a universal rule, but usually in the better projects the organizer feels he can sell to the wealthiest and the smartest," he adds.

The Shopoff Group deals in many sorts of properties including land and commercial assets in many locations. Over the past five years, however, it has concentrated on residential real estate in Southern California.

TEXAS HEDGE. Plenty of bears say the Southern California market has topped-out. And Shopoff himself says the market "has potential for an adjustment" in the short term. However, taking the long view, his group favors 5 and 10 year investments that make money. For markets like Boston and Southern California, which have seen startling runs in recent years, Shopoff says "to me a 10% or 15% adjustment is less than the appreciation that the markets have achieved in the last year."

And since he makes investments that last five years or longer, he says a temporary dip is not an overwhelming concern. "It's a long-term theory of investing," Shopoff says. "Do you believe in the long-term potential of Southern California?" He does, though he has also recently made investments in Hawaii and in central Texas, near Austin. Shopoff describes the latter as a market that "we don't think we would make as much money in" but it's a "good hedge" against any short term disturbances in the Golden State.

SIMPLE IDEA. Some of his investments have not not done as well, including low-cost housing in Arkansas and Michigan, admittedly not normally thought of as real estate hot spots. Shopoff says the primary goal of the investments was to garner tax credits for equity partners in projects for providing affordable housing and "those markets have not done as well," Shopoff concedes.

His more successful investments have often been guided by the simple idea of buying property and selling it a few years later. "Don't try to pick the highs and lows," Shopoff says.